At all three ratings firms, profits in recent years have been among the fattest on Wall Street, Waxman is expected to note. One firm, Moody's, rang up profit margins three to four times those of Exxon Mobil Corp. while assuring investors that complex mortgage-backed investments were safer bets than they really were, according to Bloomberg News.
In recent financial filings noted by the investor web blog Footnoted.org, however, Moody's confirmed it had "errors in the model" it used to rate some investments, and is "cooperating with. . . investigations and inquiries" by "states attorneys general and other governmental authorities," including the Securities and Exchange Commission.
Two former rating company employees who took issue with their firms' practices also testified Wednesday.
Frank Raiter was a former managing director at Standard & Poor's who left in 2005, after he says he refused to go along with several questionable arrangements. "They thought they had discovered a machine for making money that would spread the risks so far nobody would ever get hurt," Raiter told a Bloomberg reporter last month. Raiter could not be reached for comment.
Raiter told the committee that the models Standard and Poor's used to assess the riskiness of mortgage-related investments was flawed, but the firm resisted replacing it with a more complex -- and expensive -- model, which Raiter believed would have been more accurate. But the new model was deemed too expensive and unlikely to result in more business for the firm, Raiter told lawmakers.
"It is my opinion that had these models been implemented we would have had an earlier warning" of the foreclosure crisis, he said.
Asked about Raiter's comments, Standard and Poor's president Sharma said Raiter's new model had been tested and found unsuitable. Since then, he said, the company's model has been updated eight times. "We have been committed to updating the models," he told the committee.
The other former executive to testify, Jerome Fons, has become an advocate for reforming the rating industry since leaving Moody's Corp. last year. Fons has pointed out the glaring conflict of interest on which the rating firms are based – they are paid by the firms who will profit if their investment product gets a stellar rating – and has even suggested the lucrative industry should be replaced entirely.
A Securities and Exchange Commission investigation in June found the companies faced conflicts of interest, stemming from the fact that the investment banks trying to sell the mortgage-backed securities were the ones paying the firms to rate their products. Emails uncovered by investigators showed analysts were concerned that negative ratings would hurt their firms' income.